By: Nikki Hager, Research Associate at the Council on Hemispheric Affairs

“Cambio! Cambio! Cambio! Money exchange!” It is impossible to walk down Florida Street in downtown Buenos Aires without hearing arbolitos offering to illegally buy and sell U.S. dollars. Arbolitos lead people who want to exchange pesos for dollars into alleyways, office buildings, or false storefronts that appear to be financial entities, travel agencies, or antique boutiques. Even exchange houses that buy and sell dollars legally will often operate in the illegal market. In these cuervas, pesos are exchanged for dollars, at 125 to 150 percent of the legal rate.

Argentina’s economy is receiving a great deal of international attention, but not for its illegal dollar market. Rather, international focus is centered on whether or not Argentina is capable of paying more than $1.3 billion USD to NML Capital, as mandated by a U.S. court.[i] NML Capital is one of the so-called “vulture” firms that purchased discounted Argentine bonds following the county’s 2001 debt default. Throughout the past decade, Argentina has made agreements with 93 percent of creditors that discounted the bonds by one third. Language in the terms of the original bonds mandates that Argentina not only pay NML Capital, but also the remaining 7 percent of “holdout” creditors. In total, the payments reach over $15 billion USD.[ii]

Given that international transactions are usually carried out in U.S. dollars, the country will need to use its dollar reserves to make the payment. Of utmost concern is whether Argentina has enough dollar reserves, since they have been drastically shrinking following the 2009 global financial crisis.[iii] The $15 billion USD payment would consume over half of Argentina’s reserves, rendering other debt payments impossible, resulting in default and economic collapse.

A shortage of U.S. dollars creates numerous other problems for Argentina’s economy. Perhaps the most obvious manifestation is the existence of the “blue dollar,” a euphemism for the black market for U.S. dollars in Argentina. The blue market developed after President Cristina Fernández de Kirchner and her administration placed restrictions on the purchase of dollars in 2011. Today, dollars are only sold for travel outside the country and require documentation to AFIP, the country’s tax agency, before the purchase is permitted.[iv] The exchange rate in the blue market, however, runs substantially higher than the legal exchange rate, peaking at almost double the legal rate in May 2013. The price for the blue dollar is also extremely volatile, in part reflecting the existing economic and political climates of the country.[v]

The existence of the blue market implies a general distrust in the nation’s currency, resulting from a century of extreme economic booms and busts. Hyperinflation, numerous devaluations, and several bank defaults have left Argentines wary of the peso’s stability, causing a widespread practice of saving or investing in dollars instead of pesos and capital flight. Consequently, the aforementioned restrictions on dollar purchases were implemented to curb these practices.[vi]

In addition, the Fernández de Kirchner administration recently came under fire for falsifying government inflation statistics and other financial indicators. INDEC, the country’s statistics agency, manipulated data, making inflation appear around 10 percent in 2013. Independent economists, however, estimate the actual rate to be around 25 percent during the same time period.[vii] An underestimated inflation rate indicates artificially low poverty rates and influences other financial indicators as well, painting an erroneously rosy picture of the Argentine economy.

Given the pervasiveness of the blue dollar and the inconsistencies among the economic statistics, the value of the blue dollar can serve as an accurate indicator of the country’s economic and political climates. The presence alone of a parallel dollar signifies a demand for dollars that exceeds the amount the state is able to supply and has severe negative implications.

Dipping Reserves and Soaring Demands

The restrictions on dollar purchases were implemented with two principal goals: stop the depletion of federal dollar reserves and curb capital flight.[viii] President Fernández de Kirchner dipped into Central Bank reserves to finance budget deficits with dollars. Normally, deficits are financed through international credit markets, but Argentina largely lost its credit access following its 2001 default.[ix] The country needs dollars for other reasons beyond paying vulture funds. For example, dollars are required to finance energy imports, which recently increased substantially. The government is also required to make payments in dollars on the newly nationalized oil company YPF that it purchased from Spanish firm Repsol in 2012.[x] Additionally, dollar reserves are needed to fund international debt—payments totaling around $15 billion USD between 2010 and 2012.[xi]

The demand for dollars goes beyond international transactions. Individual Argentines often save and invest in dollars, fearing further economic instability. Since the 1970s, Argentina has used five different currencies, experienced 14 devaluations, and witnessed two large-scale bank defaults in 1990 and 2001.[xii] Any time the economy begins to show signs of faltering, Argentines take refuge in the dollar. According to the book Estoy verde: dólar, passion argentina,

“[Argentines] buy dollars like they’ve always bought dollars. The thought is, after the next devaluation, you can use dollars to purchase things at half the price… Money serves as a medium of exchange, unit of account, and a reserve of value. When it loses its function as a reserve of value, a stronger currency replaces the weak.”

As a result of their tumultuous economic history, Argentine citizens depend heavily on the U.S. dollar as an instrument for savings and investments. Thus, popular fear generated from past economic meltdowns serves as a driving force for the blue dollar market.

Argentines fear that another devaluation is coming, especially in light of the country’s rocky economic history. Pesos lose purchasing power with each sustained wave of inflation and devaluation, and recent bank defaults have caused distrust in the banking system. Argentine savers often turn to dollars as a way to store their wealth.[xiii] Stashed inside homes or stored in foreign bank accounts, the average Argentine possesses $1,300 USD, more per capita than any other country in the world outside of the United States. By comparison, their neighbors in Brazil average six USD per person.[xiv]

Furthermore, according to Estoy verde, Argentines associate fluctuations in the prices of the dollar with those found in general prices as a result of years of inflation. For example, it is assumed that if the price of the dollar increases 25 percent, then prices can be expected to increase 25 percent. The majority of young people also hold this belief, despite the fact that they never have been affected by hyperinflation.

The practice of saving and investing in dollars keeps the demand for them high. The trend is so prevalent that the government sold around 80 billion dollars to Argentine savers between 2007 and 2011.[xv] Despite the restrictions and efforts by the government to regain confidence in the peso, demand for dollars remains high. Rather than switch to the peso, numerous Argentines turn to the illegal market and pay a substantially higher price, a sign of serious mistrust in the peso.

Why are People Shouting in the Streets? Mechanisms of the Market

The practice of purchasing dollars illegally is widespread—it is estimated that an average of $10 million USD is exchanged on the blue market daily.[xvi] Despite the outward openness of the blue dollar, the internal mechanics are considerably complex.

As the majority of global transactions are carried out in dollars, Argentine firms have access to dollars through international business exchanges. Firms are still subject to dollar restrictions and regulations, although there is an incentive for businesses to engage in money laundering, since dollars can be sold at 125 to 150 percent higher on the black market.[xvii] Corretas, or brokers who have access to dollars, often work out of brokerage houses. Brokers operate on two levels: en blanco, or legally within financial markets, and en negro, on the black market. They report the majority of their earnings to AFIP, but retain a portion to sell on the black market. The brokers are in constant contact with the cuervas, or places where the dollars are sold, and make agreements regarding prices and amounts. Delivery boys then transport the dollars from the broker to the cuerva, usually on their body. Both the delivery boys and the cuervas run the risk of being robbed or stopped by police, a crime that can carry up to an eight-year jail sentence. The cuervas subsequently sell the dollars at an even higher rate and employ the arbolitos, who draw in customers from the streets.[xviii]

Dollars come from other sources as well, including from neighboring countries where it is legal to purchase them. Soy and agricultural exporters also keep a portion of the dollars they earn from exporting to foreign markets in order to sell them on the black market. This practice is especially lucrative, as the exchange rate for soy is kept artificially low, at around three to five pesos to the dollar. Agricultural exporters can then sell the dollars at 10 to 12 pesos to the dollar, doubling or tripling their original exchange rate. [xix]

There are also other means to obtain dollars. “Blue chip swaps” are when dollar-denominated bonds are purchased legally in pesos, then transferred to the United States where they are sold for dollars. Another loophole for attaining dollars is through offshore and international bank accounts.[xx] Millions of dollars flow through Uruguay, a short boat ride away from Buenos Aires. President Fernández de Kirchner has gone as far as to employ dollar-detecting dogs to sniff out and stop dollars from flowing across the border.[xxi]

Despite attempts by the Fernández de Kirchner administration to legally reduce the importance of the dollar and restore public confidence in the peso, there is no real effort by the government to stop the illegal blue dollar market. Rather than crack down on the illegal exchange, state officials meet with important brokers to negotiate the price of the blue dollar.[xxii]

The Value of Blue Dollars as an Economic Indicator

According to Estoy verde, the value of the blue dollar reflects basic supply and demand models. As the demand for dollars increases, so does the price of the blue dollar. The price of the blue dollar consistently changes with economic and political events. Given the historic practice of buying dollars during economic declines, it follows that an increase in the price of the blue dollar reflects popular distrust in government policy and the peso.[xxiii]

Price of dollars over time.

Photo Credit: Dollar blue.net

Initially, the value of the blue dollar correlated with increasing restrictions implemented by the government. President Fernández de Kirchner enacted the first round of restrictions in December 2011 that required AFIP approval for individual transactions.[xxiv] In May 2012, approvals for dollar purchases plummeted, causing the price of the blue dollar to increase significantly. Blue dollar prices reached as high as six pesos to the dollar that month, compared to the legal rate of around four and a half. In July of the same year, the administration explicitly banned the purchase of dollars for saving, causing the price to skyrocket to almost seven pesos compared to the legal rate of 4.6.[xxv]

The more restrictions imposed to prevent capital flight, the higher the price of the blue dollar. The price rose sharply again in May 2013, following legislation granting amnesty for dollar-hoarding, tax evaders, and money launderers to encourage investors to bring dollars back into the country.[xxvi] This occurred at the same time that the administration began experiencing scrutiny for both its high levels of inflation and faulty statistics.[xxvii] Demand for dollars skyrocketed, causing the biggest spread to date, 5.25 pesos to the dollar to the black-market 10.5.[xxviii] Despite a significant gap between the rates, the administration vowed there would not be another devaluation.[xxix]

However, the official exchange rate began to fall sharply in January 2014, due in part to shrinking reserves. The administration reneged on its vow and devalued the peso to eight pesos to the dollar. Its value dropped 18 percent in that month alone, making it among one of the world’s worst preforming currencies. The blue dollar soared once again, reaching an all time high of 13 pesos to a dollar in February.[xxx]

For the next few months following the devaluation in February, economic conditions appeared to improve; the blue dollar was falling, interests rates were up, and a new, more accurate consumer price index started to restore INDEC’s creditability.[xxxi] However, just as the economy was looking up, the blue dollar began to rise again in early June in anticipation of the upcoming decision in the U.S. Supreme Court case regarding Argentina’s sovereign debt. After the Court refused to hear the case and the administration’s refusal to pay the debt holders, the price climbed again. It then fell significantly once the administration agreed to negotiate.

The Future of the Blue Dollar

While Argentina was granted a month long extension to come to an agreement with the holdouts, the future of Argentina’s debt payments remains unclear. Until it appears that the country is able to make a deal, it is likely that the price for blue dollars will increase.

A number of scenarios could play out in Argentina that could influence the value of the blue dollar.

First, the government has effectively issued 40 billion new pesos since January. Such a sizable increase in the money supply could continue to send inflation soaring, further reducing the value of the currency relative to the dollar. High inflation also jeopardizes already damaged confidence.[xxxii]

Second, other factors could potentially diminish the size of the country’s dollar reserves as well. Instability in Iraq and the Middle East threatens to increase the price of oil, increasing the cost of energy imports, which again needs to be paid in dollars. Additionally, there is a drought that will likely harm soy and agricultural exports, which are purchased in dollars. Fewer exports mean fewer dollars for Argentina’s reserves.[xxxiii]

However, the most daunting scenario would occur if Argentina is unable to come to an agreement with the holdout firms, therefore leading to a default on its debt. When Argentina defaulted on over 100 billion dollars of debt in 2001, it caused massive economic turmoil and resulted in the corralito, or bank closures. The poverty rate surpassed 50 percent of the population. Today, its debt is double what it was in 2001. The fall out from a default could be catastrophic.[xxxiv]

In any combination of these scenarios, it appears that the value of the blue dollar will climb. The risk of default threatens already weary confidence in the banks, which could cause more Argentines to withdraw pesos from saving accounts in order to invest in black market dollars. The possibility of another devaluation also looms, as the government’s ability to use reserves to prop up the official exchange rate. This could exacerbate the spread as well.

President Fernández de Kirchner’s goals of stabilizing reserves and stemming capital flight have failed. Given the historic ties between the dollar and confidence in the economy, dollar restrictions further mistrust in the local currency. Rather than spending and investing in pesos, Argentines pour wealth into the black market, doing nothing for the country’s economy.

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